Shipping Rates in the Near Term: Weak Demand, Oversupply, and Post-Panamax Ships

Spend Matters welcomes a guest post from Sunny Liu, an economist at IHS.

The shipping markets have been depressed over the past few years, reflecting a combination of persistent weak demand and over capacity. In order to succeed or even survive against this backdrop, carriers have repeatedly tries to implement general rate increases (GRIs). However, most of these have failed to hold, due to the intensive competition in the market and weak price discipline among carriers. Consequently, carriers have shifted their focus to the challenge of how to cut costs. One approach has been to build bigger ships to achieve cost competitiveness.

In particular, the growth of large, so-called Post-Panamax ships has been accelerated by the expansion of the Panama Canal project. Currently, the Panama Canal can only handle ships up to about 4,800 twenty-foot equivalent units (TEUs). In contrast, after the third set of locks opens to commercial traffic in 2016, it will be able to accommodate ships with capacities of up to 13,000 TEUs.

Post-Panamax can significantly reduce the cost compared to the current Panama ships: assuming both type of ships have a same utilization level (e.g. 80 percent), the cost per TEU moved by Post-Panamax ship will be only 65 percent of that for the current Panamax ship. As a result, there is a surge in the delivery of Post-Panamax ships geared up for the opening of the expanded Panama Canal.

Indeed, according to IHS Fairplay, the inflow of container ships with capacity between 4,800 and 13,000 TEUs will increase this year by 35 percent (in terms of TEUs). In contrast, the delivery of ships with capacity below 4,800 TEUs will fall by 18 percent compared to last year. This is a clear trend showing carriers’ intention of adopting Post-Panamax ships to increase efficiency.

However, the continued ordering of bigger container ships will further widen the gap between weak demand and a serious glut of supply in the market. As a result, freight rate growth will remain constrained. Furthermore, on the back of the risk of higher fuel prices (due to persistent geopolitical risks to global oil supply), carriers’ profit margins will be squeezed further.

This is a dilemma for carriers. On the one hand, in order to remain competitive, shippers order bigger ships to achieve greater economies of scale and more energy efficiency. On the other hand, the inflow of bigger ships makes the oversupply situation worse and pegs freight rate growth down further.

What are the possible solutions for this dilemma? What is most likely is that we will see structural changes within the shipping industry. The emergence of giant alliances by major carriers is the first sign of such restructuring, including the network of P3, G6, and CKYHE. Although the full ramifications of forming giant alliances is unclear, it is expected squeeze the market share of other carriers that operate smaller ships, due to the cost effectiveness of alliances. The bottom line, though, is that the growth of freight rate will remain stagnant in the near future.